Do Holdout Problems Justify Compulsory Right-Of-Way

Do Holdout Problems Justify Compulsory Right-of-Way

Purchase and Public Provision of Roads?*

Bruce L. Benson

DeVoe Moore Distinguished Research Professor

Department of Economics

Florida State University

Tallahassee, FL 32306

* This manuscript was prepared for the Independent Institute for inclusion in Private Roads to the Future edited by Gabriel Roth. I want to thank Alex Tabarrok and Gabriel Roth for their helpful comments and suggestions on an earlier draft.

I. Introduction

One of the alleged "justifications" for government provision of highways and roads is that the power of compulsory purchase is necessary in order to overcome holdout problems and obtain right-of-way properties (Goldstein 1987).[1] After all, this argument continues, only the state has such power, so the private sector would be unable to supply the efficient amount of roads and highways.[2] This market-failure justification for public roads is examined from three different perspectives below to demonstrate that it is not valid.[3] The first, and perhaps most obvious, point regarding the compulsory-purchase justification for government provision of roads is that even if this power is required to obtain a right-of-way, the road itself does not have to be sited, constructed, financed or operated (e.g., maintained, policed) by the government. Section II briefly summarizes some of substantial historical and modern evidence demonstrating that members of the private sector are able, and indeed, quite willing to site, construct, finance, and operate roads if they are allowed to. The implication is that even if compulsory purchase is required in order to obtain s right-of-way, that right-of-way can be turned over to the private sector which can then build and operate the road. Section III turns to a direct examinations the alleged market-imperfection justification for the use compulsory purchase to obtain a right-of-way properties: transactions cost due to the "holdout" problems that are assumed to prevent private sector acquisitions of multiple contiguous land parcels for a roadway (Fischel 1995, 68-70). It is demonstrated that the holdout problem is not nearly as severe as it is assumed to be when private entities are making the purchase. Therefore, while government entities may face significant holdout problems, the magnitude of any market failure that might actually exist with a privatized road system is much less significant than this holdout justification for public roads assumes. Furthermore, the use of compulsory purchase actually is undesirable for a number of government-failure reasons, as explained in Section IV. Therefore, even if there is a potential market-failure limiting the ability of private road providers to obtain right-of-way properties, Section V concludes, not only that: (1) the "need" for compulsory purchase does not justify public provision of roads (as demonstrated in Section II), but that compulsory purchase through government itself is not even justified for the provision of private roads, because (2) the probability of market failure is low in the absence of this power (as illustrated in Section III), and because (3) there is a substantial degree of government failure accompanying the power which appears to more than offset any benefit from overcoming the holdout problem (described in Section IV).

II. Private Provision of Roads Using Compulsory Purchase Powers

Tentatively assume that compulsory purchase powers actually are necessary for obtaining a right-of-ways for a highway or road (i.e., ignore the presentation in Sections III and IV). Since private entities do not have this power, this assumption implies that the government must be involved in the process of road provision. The government could use the power to obtain the right-of-way chosen by a private entity (Roth 1996, 199), however, which then finances, builds, and operates (maintains, polices) the roadway. Indeed, government agencies rarely build roads themselves (i.e., by using government owned construction equipment and government employees to construct roads). Most road construction is contracted out to private firms. Therefore, the real questions about private versus public roads have to do with the operation, siting, and financing of roads.

II. 1. Must the state operate roads? Government "ownership" of roads means that the government is (or more accurately, taxpayers are) responsible for paying the cost of maintenance and traffic-rule enforcement (both of which can be provided by private firms under contract[4] ) but this is not necessary. Consider, for example, that

the decline of St. Louis, Missouri [had] come to epitomize the impotence of federal, state, and local resources in coping with the consequences of large scale population change.[5] Yet buried within those very areas of St. Louis which have been experiencing the most radical turnover of population are a series of streets where residents have adopted a program to stabilize their communities, to deter crime, and to guarantee the necessities of a middle-class life-style.... The distinguishing characteristic of these streets is that they have been deeded back from the city to the residents and are now legally owned and maintained by the residents themselves (Newman 1980, 124 - emphasis added).

In 1970, for example, Westminster Place in St. Louis had an estimated 6,000 cars per day using the street to avoid traffic lights on nearby major boulevards, and prostitutes found the neighborhood to be an attractive business area. But, the homeowners of Westminster Place (and several other neighborhoods) "found an unconventional solution to a common problem": they petitioned the city to deed the streets to them (Gage 1981, 18). The city complied in return for the residents' assumption of responsibility for street, sewer, and streetlight maintenance, garbage pickup, and any security services above fire and police response. The titles to the streets are now vested in incorporated street associations made up of dues paying property owners whose homes border the streets.[6] The street associations have the right to close their streets to through traffic, install speed bumps, and take other actions in order to control street use.[7] By 1982, the St. Louis metropolitan area had more than 427 private street-providing organizations (the list was known to be incomplete), according to Parks and Oakerson (1988, 9 and 84; also see Foldvary 1994, 191).

Note that the St. Louis privatization of streets actually suggests that even if compulsory purchase is necessary for obtaining right-of-way properties, this is not a particularly important issue in a relative sense, at least in modern industrial economies. After all, extensive right-of-way networks have already been condemned which could be transferred to private hands, creating a vast network of private roads without any additional condemnations (Roth 1996, 198). Thus, if the compulsory purchase issue is a valid source of market failure that would prevent the creation of new private roads (but see Sections III and IV) it actually only applies at the margin when an existing network must be expanded.

II.2. Must the government determine the location of new roads and finance their construction? Local government officials may have initially decided where the now-privatized St. Louis roads had to be, and tax revenues may have paid to have them built.[8] These also are not necessary tasks for government, however. For instance, residential developments all over the United States actually include private streets laid out, paid for, and built by developers (Foldvary 1994) [note that most of these developers do not rely on compulsory purchase to obtain right-of-way properties]. Developers charge for the cost of the streets they build when they sell lots or homes, and included in the contracts are various stipulations about regular payments for ongoing costs such as street maintenance, security, and so on. Generally, as residents move in they form ownership associations, and at some point these associations join with and ultimately replace developers in coordinating the purchases of various services like street maintenance and security. Both of the Tallahassee, Florida developments I have lived in have private streets owned by homeowners associations, for instance. Annual fees for road maintenance are paid by residents.[9] Private streets are not unique to residential developments either. Large proprietary business operations also provide streets and even highways, as well as traffic policing. For example, Shearing and Stenning (1987) detail the massive role of private security and the resulting order in Disney World [also see Foldvary (1994)], a huge complex with hundreds of miles of private roads and highways.[10]

Roads and highways that connect residential areas to business areas, and that connect different communities can also be privately financed and maintained. For instance, three groups in Great Britain were the primary demanders for networks of good roads as long distance travel increased during the middle ages: merchants, representatives of the church, and representatives of the central government.[11] Of these groups, however, it was the church and the merchant community that met the demands, not the government. Furthermore, after the government undermined the incentives of the church to maintain roads, those that were not maintained locally were taken over by privately controlled turnpike trusts. These private turnpikes peaked in about 1830 when there were 1,116 Trusts operating 22,000 miles of roads (Roth 1996, 176). The Turnpike era came to an end, in large part, because there was significant political opposition to the trusts from those involved in competitive transportation modes such as the river and canal barges and railroads, from trade centers that already had effective transportation connections and feared competition from other centers where road connections were to be improved, from some landowners and farmers who feared that better roads would make it easier for their low-wage laborers to be attracted away, and from those farmers supplying local markets who feared that improved roads would bring in competition from distant suppliers. In addition, large scale agricultural interests and, in some areas, industrial groups, were particularly effective at obtaining government mandated exemptions from tolls. Such exemptions grew over time and seriously reduced the revenues of the trusts, undermining their ability to maintain the roads.

American history reveals similar experiences with private connecting roads. The first toll road company in the U.S. was chartered by Pennsylvania in 1792, for a highway between Philadelphia and Lancaster. Klein and Fielding (1992) report that between 1792 and 1845 1,562 turnpike companies in the Eastern United States established over 10,000 miles of roads. As Gunderson (1989: 192) notes, "Relative to the economy at the time, this effort exceeded the post -World War II interstate highway system that present day Americans assume had to be primarily planned and financed by the federal government." Similarly, Klein and Yin (1996) point out that about 150 private toll roads were opened in California between 1850 and 1902. Klein (1990) explains, however, that numerous government mandated toll exemptions for powerful interest groups tended to undermine the incentives to build private toll roads (government regulations often explicitly prevented profit taking, just as in Great Britain[12]).

Private connecting roads are also enjoying a resurgence today. Many developing countries are franchising roads to private firms which construct the roads and them operate them, charging tolls to earn the costs of construction and operation, and to cover franchising fees paid to the government (Pereyra 2002). Indeed, providing such roads are so attractive, in part because of their impact on real estate values, that it is becoming increasingly common for governments to auction franchises (Engel, et al. 2002). Roth (1996, 180-197) also documents several private road projects in developing countries, but in addition, he cites examples in developed countries, including two recent private highways in Great Britain (the Dartford River Crossing Ltd.'s toll bridge crossing the Thames, and Midland Expressway Ltd.'s M6-Toll Road, a 27 mile expressway to relieve congestion in one of England's busiest urban areas). The United States also has begun to develop and even encourage private-highway projects. In fact, the Intermodal Surface Transportation Efficiency Act (ISTEA) of 1991 attempted to stimulate privately provided toll roads, bridges and tunnels in the United States (as long as they are not part of the interstate highway system) by making them eligible for a 50 percent grant from the Highway Trust Fund, and in an effort to take advantage of these available funds a number of states have passed their own legislation to allow private provision of roads. However, some of the largest and most important private highway projects in the U.S. (e.g., the Dulles "Greenway" project in Northern Virginia and the State Road 91 project in Orange County, California) have refused the federal funds in order to avoid the added complications that accepting such funding entails.

Clearly, private entities can and do finance, build, and operate roads, and they would do much more of it if they could retain profits. Thus, even if compulsory purchase is necessary in order to obtain right-of-way properties, the state could purchase and then transfer the land to private entities. But are compulsory purchase powers actually necessary to obtaining property for a road right-of-way?

III. Holdouts: Do They Justification Compulsory Purchase?

Resources, such as land for a right-of-way, can be taken through compulsory purchase, but from an efficiency perspective, voluntary exchange is clearly more desirable if it is possible. To see why, suppose one person, individual A, wants to obtain possession of a tract of land that is currently legally controlled by another person, individual B.[13] One fundamental fact that must be recognized is that no voluntary exchange will take place unless both parties expect to be better off as a consequence. Therefore, assume that B is willing to sell the property if she can get enough for it to buy another piece of property that she can purchase for $300,000. That is, she values the benefits from owning the current property at something less than the benefits that she could gain from having the alternative which costs $300,000. This brings up a second key point. Decisions are made on the basis of opportunity costs: the next best alternative that must be forgone. While it is common to talk about the value of things in terms of monetary units, money is simply a convenient common denominator that can be used to express an estimate of the value of things. Finally, recognize that B clearly will be better off if she can sell her land for something more than $300,000 because she can get the other land and have money left over to buy something else.

Suppose that A has plans to use the parcel of land in a way that will generate considerable income, and would be willing to spend up to $500,000 to get it (i.e., if it cost more than $500,000 then there is a more attractive alternative use of his money). A third fundamental point is that the value a person places on something is subjective: it depends on that person's own opportunities (skills, knowledge) and preferences (tastes, willingness to take risks, time horizon). Indeed, if people did not place different relative values on goods and services there would be no reason to enter into voluntary exchanges. Voluntary exchanges occur because both parties trade something they personally value less for something they personally value more. Therefore, if a successful voluntary exchange takes place this asset will be allocated to a higher valued use.[14] Of course, the goal of allocating things to their highest valued use according to the subjective value of individuals may not be seen as an attractive normative objective by some readers. Note, however, that the difference between the values the seller and the buyer place on the land is a cooperative surplus or a potential gain from exchange, and the actual distribution of this surplus depends on the price at which the exchange takes place. Suppose that A initially bids $200,000, for instance, but B turns the bid down, perhaps with a counter offer to sell for, say, $550,000. A rejects but counters, and they continue to adjust their offers and counter offers until they arrive at a price that satisfies both. Any price between $300,000 and $500,000 means that both parties are better off. Suppose for instance, that the price is $420,000. Then A comes away from the exchange thinking, "I sure got a good deal: I was willing to pay $500,000 but I only had to spend $420,000 - I really took advantage of her." B similarly thinks, "I sure got a good deal; I would have sold for $300,000 but I got $420,000 - I really took him!" Thus, in terms of "welfare analysis," the society in which these two individuals live has experienced an increase in "social welfare" because both are better off and no one is worse off. Voluntary exchange tends to increase "wealth" (subjective well-being) and it does so in what economists refer to as a Pareto efficient way. Pareto efficiency refers to the idea that something is desirable from an efficiency perspective if it makes someone better off without making anyone else worse off. In general, voluntary exchange does this.[15] In fact, such exchange generally makes both parties better off. Exchange is not costless, of course, and such transactions costs can be high enough to prevent a potentially welfare enhancing voluntary transfer.